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CECL, the New Credit Losses Standard, and Clearwater Updates

CECL, the New Credit Losses Standard, and Clearwater Updates


The current model for recognizing credit losses for many financial assets is an “incurred loss” model. Basically, this model delays recognition of losses until it is probable a loss has been incurred. This made the valuation of certain financial instruments on the balance sheet less useful or reliable, which was exacerbated by the financial crisis in 2008.

On June 16, 2016, the FASB issued Accounting Standards Update (ASU) 2016-13, Financial Instruments – Credit Losses (Topic 326). This update requires immediate recognition of management estimates of Current Expected Credit Losses (CECL) for assets held at amortized cost. Although the CECL model does not directly apply to securities held as Available-for-Sale (AFS), updates have been made to the AFS impairment standard such as requiring that credit losses be recognized as an allowance instead of a write-down.

For public SEC filers, the updates are effective for fiscal years beginning after December 15, 2019. For all other public business entities, the updates are effective for fiscal years beginning after December 15, 2020. For all other entities, the updates are effective for fiscal years beginning after December 15, 2021.

Assets Measured at Amortized Cost

The scope of the CECL model is intended for assets held at amortized cost, including: financing receivables, Held-to-Maturity (HTM) debt securities, reinsurance receivables from insurance contracts, certain other receivables, certain net investments in leases, and off-balance sheet credit exposures not accounted for as insurance. It is required that these assets are presented at the net amount expected to be collected. The measurement of an expected credit loss must be based on relevant information of past events including historical information, current conditions, and reasonable and supportable economic forecasts. The use of a discounted cash flow model is allowed but not required. Additionally, assets with similar risk characteristics must be pooled together when estimating credit losses.

AFS Securities

While many aspects of the impairment model remain the same, there are some key differences to be aware of. Securities will still be analyzed on an individual basis and will only be considered for impairment if the fair value is less than the amortized cost basis. However, the length of time a security has been in an unrealized loss position and the volatility of the fair value of the security should not be factors to conclude that a credit loss does not exist. If an entity decides to sell the security or, more likely than not will be required to sell the security before the recovery of its amortized cost basis, the amortized cost basis should still be written down to the fair value.

For the remaining securities where fair value is less than amortized cost, an entity will still need to determine whether a credit loss exists. If it is determined that a credit loss exists, it should be recorded as an allowance rather than a direct reduction in amortized cost. The book value is the net of amortized cost and the allowance amount. The allowance is limited by the amount by which the fair value is less than the amortized cost (fair value floor).

The amount of the credit loss or allowance is the difference between the current amortized cost and the present value of future expected cash flows. A discounted cash flow model must be used and be discounted based on the effective interest rate implicit at the date of acquisition. The estimates of expected future cash flows should be based on the entity’s best estimate based on past events, current conditions, and on reasonable and supportable forecasts.

Purchased Financial Assets with Credit Deterioration

For purchased financial assets with a more than insignificant amount of credit deterioration since origination (PCD assets), the allowance for credit losses will be determined using the same guidance above once classified as either HTM or AFS. However, the initial allowance should be added to the purchase price instead of recognized as an expense (balance sheet gross up). Subsequent changes to the allowance will be recognized in the income statement. Interest income should be recognized based on the effective interest rate, excluding the initial allowance at acquisition. This allows for a nuanced approach for the initial recognition of PCD assets, but unifies their subsequent measurement with other assets.

Transition Guidance

For most assets, a modified retrospective approach to adopting the new guidance will be correct. This would mean recognizing the allowance amount with an offset to retained earnings.

For securities that have previously recognized an Other-Than-Temporary Impairment, a prospective adjustment should be used, maintaining the same amortized cost before and after the effective date.

For PCD securities, a prospective approach should also be used, including adjusting the amortized cost to reflect the addition of the allowance for credit losses.

Clearwater Impact

Clearwater accounting experts and product owners have followed this guidance change closely to ensure that we are prepared. To help support the accounting for allowances, Clearwater created a new “Allowance for Losses” contra-asset balance and an “Allowance Expense” profit and loss account. These balances will be used when a new Allowance is applied under the activity type “Allowance.” As the Allowance balance can change up or down over time, Clearwater will create the necessary change activity if a new Allowance balance is specified. The new balances are currently available on the website (i.e., the Clearwater solution), including in the general ledger. As per the guidance, the allowance amounts for PCD assets will be recorded as a balance sheet gross up and will not initially be recorded as an expense. Allowances for AFS securities will be subject to the fair value floor (the allowance will not exceed the unrealized loss).

Consistent with the current impairment process, Clearwater will not automatically calculate or provide an allowance amount on a client’s behalf. We anticipate that allowance amounts will be updated in the system in two ways:

  1. Client-supplied
  • Currently, clients have the ability to provide Clearwater an allowance amount by lot to be entered into the system as of a given date. This bulk data can be provided to your client services representative to be entered into the system. Once entered, Clearwater will use this information to process the appropriate accounting activity and reporting.
  • We will also provide a way for clients to enter an allowance on a lot by lot basis through the website. We are investigating ways to potentially allow clients to enter allowance amounts in bulk on the website. We will continue to allow clients to enter intent to sell and more likely than not required to sell impairments through the website individually with a new option to enter these in bulk.
  1. Third-party integration
  • There are several third-parties that provide allowance calculations to help support this new guidance. We are currently working with some of these third-party providers to try and integrate and streamline a solution that will include the calculation of the allowance and the subsequent accounting and reporting. The pricing and functionality details have not yet been finalized. If this is a process you are considering, more information can be provided once finalized.

Clearwater also plans to support reports to help with the new disclosures required by this update. We will continue to keep the existing impairment reports as clients transition to this new guidance over time.

  1. Two new GAAP impairment reports will be created.
  2. A new Allowance Rollforward report will be created. The purpose of this report would be to support the requirement to provide a rollforward of the allowance for credit losses.
  3. For clients that hold PCD assets, a new PCD rollforward will be available. 

While some of these changes are complete, some are still in progress. As we continue to iterate and receive feedback, some of these plans may change (additional information will be provided when these plans are finalized). These changes will impact each client differently, so it will be important to work with your account manager to get your accounts properly set up and to develop an efficient process moving forward. Please also reach out to your account manager if you have additional questions. 

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